Last month, the Bank of International Settlements released its hotly anticipated triennial survey on foreign exchange trading, which again saw the Chinese renminbi creep further up the list of most-traded currencies.
The onshore and offshore renminbi exhibited the biggest increase in market share since the 2019 survey, being on one side of 7% of all trades in 2022 – up from 4% in 2019. As a result, the currency has moved from eighth to fifth in the rankings of the top traded currencies.
It chimes with other measures in the market. At the end of the first quarter, US dollar/offshore renminbi was ranked as the third top currency pair on EBS, the platform stated on its website in May. And privately, some sell-side traders remark that USD/CNH has on some days been even more liquid than EUR/USD.
A lot has changed since the 2019 survey. The opening up of China’s capital markets has accelerated, boosting activity in its currency market. The China Foreign Exchange Trade System, the country’s onshore interbank market, has increasingly been giving foreign dealers access and recently extended its trading hours to make it more attractive.
Furthermore, domestic companies have been encouraged by China’s State Administration of Foreign Exchange to use derivatives to achieve risk-neutrality in their hedging programmes. As a result, a record number of firms have reportedly traded swaps, forwards and options in the first nine months of the year.
Foreign investors have also been increasingly active in the currency. October saw $206 billion notional of USD/CNY options hit the market, up from a monthly average of $72 billion in the fourth quarter last year, according to trade repository data from the US Depository Trust & Clearing Corporation, which includes trades with at least one US counterparty. Much of this was on the back of speculation from hedge funds about the rising rate.
Not only does the hedging of these derivatives lead to increased spot flows from market-maker hedges, it also allows dealers to facilitate increasingly large options flows in the currency without breaking a sweat. For instance, Morgan Stanley Investment Management’s bet on a weakened renminbi, which involves regular trades of $4 billion notional or more, has been handled by the market with little disruption.
Geopolitical factors have helped as well. Earlier this year, it was reported that Saudi Arabia was considering accepting renminbi for Chinese oil sales. In addition, Indian companies are said to have purchased Russian coal using the currency to avoid breaching western sanctions.
So, the trading access and liquidity is there, and overall OTC turnover – as reported by dealers’ sales desks – is higher than the Aussie and Canadian dollars. With sterling’s recent behaviour being compared to that of an emerging market, is it now time for dealers to treat the renminbi as a G10 currency?
Some traders admit to risk managing the currency like a G10 pair and say the liquidity is similar, so the spreads they charge are similar. However, they warn that the risks associated with trading in China’s controlled capital markets mean it can turn back into an emerging market currency very quickly.
This was particularly evident in September when the People’s Bank of China warned against traders speculating on the renminbi’s downward trend. The central bank also hiked the amount local dealers are required to deposit with it against notionals of FX forwards from zero to 20% – lifting the cost of shorting the currency via onshore FX forwards.
There are also the added complications of managing both an onshore and offshore trading programme. Most foreign market participants hedge their Chinese investments in CNH. However, for passive investment managers that track Chinese indexes, they are denominated in CNY. This generates a price differential between the CNH and CNY – otherwise known as the basis – and this can move significantly on occasion.
Demand for trading in China’s capital markets will continue to fuel demand for currency hedging and speculation. But as these onshore/offshore challenges persist and the threat of central bank action looms over liquidity, it may still be some years out before banks can consistently price and risk manage China’s currency as a G10 market.